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Thailand, Russia, Mexico, Brazil. They're among the nations where investors were badly burned in emerging markets in the late 1990s when one sovereign borrower after another defaulted on its debts or ran into major financing difficulties. That's the main reason cross-border capital flows into developing countries plunged from almost $300 billion in 1997 to just $110 billion in 2002.
Now, after years of caution, mutual funds, insurance companies, and other big institutional investors from Europe and the U.S. are regaining their confidence and channeling fresh money into emerging-market equities and bonds. The Institute of International Finance, the Washington (D.C.)-based association of leading international commercial and investment banks, now predicts that capital flows will rise to around $160 billion this year, sharply raising its May estimate of $139 billion.
The upswing is partly the result of historically low interest rates in the developed world, which are encouraging even conservative investors to seek higher returns in emerging markets. IIF Managing Director Charles Dallara also points out that confidence has been strengthened by international policies to improve crisis-prevention and -management.
FEWER DEFAULTS. Among these are voluntary approaches to debt restructuring, including the broad use of collective-action clauses. CACs in bond contracts facilitate debt restructuring by providing an orderly, pre-agreed framework within which debtors and creditors can negotiate new payment terms should a country be in danger of default. As CACs become widespread, proponents say they'll promote global financial stability and reduce the risk and severity of crises by giving investors a greater degree of security.
Another major reason for the upswing is the improving creditworthiness of most developing countries. Standard & Poor's Rating Services says the number of defaults by sovereign governments declined in this year's first three quarters. S&P says just three new governments -- most notably Argentina's -- have defaulted so far this year. That compares with five in 2002.
At the same time, five sovereigns have emerged from default and resumed normal debt service. In all, S&P estimates, 26 governments are in default on bonds and bank loans, compared to 28 last year. The value of sovereign bonds and bank loans in default has also fallen, to about $126 billion from $134 billion in 2002. "We expect the number of sovereign issuers in default, and the value of defaulted debt, to fall further in 2004," said David T. Beers, managing director of S&P's sovereign and international public finance ratings group.
RISING GLOBAL TIDE. Several successful debt workouts this year have helped reassure bondholders that crises can be defused. Uruguay averted default in May by concluding a big debt swap that extended maturities on billions of dollars worth of bonds for five years. And in August, Cameroon closed a deal with London Club bank creditors. Meanwhile, several other sub-Saharan governments, along with Serbia and Montenegro, are likely to resume normal debt service this year or next.
Also helping is an improving global economy, which is expected to grow by 4% in this year's second half. That will boost emerging-markets exports, improving their current accounts and strengthening their government finances. World Bank economists predict developing countries as a whole will register a current-account surplus of more than $72 billion this year. That's about the same as last year but almost three times the $27.8 billion recorded in 2001.
As a result, many nations' creditworthiness should improve. Given these trends, economists say, investors are likely to shunt more money into emerging markets over the next two years.
That's no guarantee, however, that the finances of emerging economies will stay healthy over the long term. "We expect sovereign default rates to gradually rise again," says S&P's Beers. For the immediate future, though, economists say the positive trends should encourage investors to pump even more money into emerging markets. By David Fairlamb in Frankfurt